Fraudulent Transfers to a Trust: Alter Ego and Veil Piercing Remedies

Take-Away: Creditors sometimes seek to set aside transfers by a settlor to an irrevocable trust claiming that the transfer of assets to the trust is a fraudulent conveyance. Courts have on occasion resorted to a couple of equitable remedies called either (i) the trust is the alter ego of the settlor, or (ii) the veil of the trust is pierced to access assets held in the trust to satisfy the creditor’s claim. These equitable theories that make a trust’s assets available to satisfy creditor claims is most often the case where the formalities of creating the trust have been ignored, or the settlor has continued to use the trust’s assets has his or her own, in effect ignoring the trustee’s legal ownership of the assets held in the trust. More recently some disgruntled creditors have pursued novel remedies against trusts called reverse alter ego and reverse veil piercing. A federal court earlier this year refused to apply these two reverse theories of recovery, with some interesting comments in a concurring decision about the propriety of applying alter ego and veil piercing remedies to trusts.

Case: Church Joint Venture, LP v. Blasingame, 2020 WL 284527 (Sixth Civrcuit, January 21, 2020.)

Facts: I will spare you an extended recitation of facts because they are long and admittedly highly confusing. Suffice it to say that over an extended period of time the debtors, Earl and Margaret, husband and wife, and their adult children, entered into a web of multiple transfers of assets, starting in 1983, to several irrevocable trusts, corporations and investment companies while they were obligated on bank loans. The bank loans were later assigned to Church Joint Venture, LP. Earl and Margaret, the debtors, filed for bankruptcy in 2009. The Bankruptcy Court denied the discharge of Church’s claim in bankruptcy finding that Mr. and Mrs. Blasingame had deliberately concealed assets and income from their creditors. This lawsuit was a follow-up to the refusal to discharge the Blasingames’ debts owed to Church. Church filed the lawsuit claiming that the Blasingames used the trusts and corporations to conceal their personal assets and income, such that the trusts and corporations were effectively the alter egos of Earl and Margaret. The issues in this litigation was whether Earl and Margaret’s multiple transfers to the irrevocable trusts, several corporations, and to their children, were all voidable as fraudulent transfers, i.e. transfers that either rendered the debtors insolvent, or they were insolvent when the transfer were made. Church, as the creditor, filed the lawsuit claiming, in part, the theories of reverse alter ego and reverse veil piercing in an attempt to access trust assets to satisfy its claims.

Trial Court: The District Judge found that Earl and Margaret had transferred money and real property to one trust as a fraudulent conveyance. However, the District Judge refused to enforce Church’s claims for reverse alter ego and reverse veil piercing on the grounds that Tennessee does not recognize those remedies. The federal court was involved because of diversity of citizenship, but it was required to follow the laws of the state that governed the loan to the Blasingames.

Appellate Court: The Court of Appeals sustained the trial judge’s decision on the grounds of a lack of evidence to support the equitable remedies of reverse alter ego and veil piercing. In reaching this decision, the Court made a couple of observations with regard to the equitable remedies as they apply to irrevocable trusts, although the Court insisted on calling them claims, which they are not, they are only remedies to address fraudulent conveyances.

Equitable Remedies: Veil piercing and alter ego remedies are not the same thing according to the Court.

Veil piercing is a remedy (not a ‘claim’ as referred to by the Court) by which a second party (a trust) is held vicariously (indirectly) liable for the first party’s (settlor of the trust) debts.
Alter ego is where two distinct parties (settlor and trust) are treated as the same party, such that liability applies to both (settlor and the trust.)
Despite that technical distinction, alter ego and veil piercing are often used interchangeably by courts. The Court then pretty much conceded that they are the same thing, so it is not readily apparent why the Court needed to provide a tutorial why the two equitable remedies, aka ‘claims,’ are different when it ultimately concluded that they are the same. [But I digress.]
Reverse alter ego and veil piercing work in the opposite direction.
Alter ego and veil piercing are rare remedies. Reverse alter ego and reverse veil piercing are even more rare and thus more controversial.

To conclude, the assets held in the trusts and corporations were not made available to Church, but the Court only said the trial judge was correct that there was insufficient evidence to apply the equitable remedies, but with little discussion on why the evidence was lacking.

Concurring Decision: Perhaps more enlightening than the tutorial the Court’s primary decision provided to deny the equitable remedies of reverse alter ego and reverse veil piercing in the absence of evidence, was the concurring decision of Judge Sutton (statements from which are consolidated into the following paragraph.)

[I will] add a word (or two) about my discomfort with incorporating ‘veil piercing’ and ‘alter ego’ theories into trust law. Both concepts originate in corporate law, and both concepts should stay there…Restated, the purpose of a veil is just that. To pierce the veil of a corporation or entity which has a liability veil. But trusts do not have a liability veil to begin with, thus there exists no veil to pierce. Alter ego may be more applicable since a trustee could be the alter ego of the debtor.….Better, in my view, is to call a problematic trust what it is: invalid, because its purpose is unlawful, because it is contrary to public policy, or because it is a self-settled spendthrift trust. Trust law has a vocabulary of its own. Departing from it invites confusion and risks leading courts to disregard the form of a trust even where it isn’t formed for an illegal purpose, and even where there is the requisite separation between beneficiary and trustee.”

Michigan Trust Code: As has been reported in earlier missives, in Michigan for a trust to be valid, it must have a lawful purpose that is not contrary to Michigan public policy and possible to achieve. [MCL 700.7404.] There is no definition of Michigan’s public policy, leaving that up to the courts to decide, i.e. common law. [Restatement (Second) of Trusts, Section 59; Restatement (Third) of Trusts, Sections 28 and 29; In re Mardigian Estate, 502 Mich 154 (2018).] Presumably a trust that is formed for the express purpose of defrauding the settlor’s creditors would be contrary to Michigan public policy from the get-go, and thus an invalid trust from Judge Sutton’s perspective. Less clear is when a trust is legally formed with a proper purpose in mind, such as to provide lifetime benefits to the settlor’s grandchildren, but at a later date the settlor transfers additional assets to the trust which had the effect of rendering the settlor insolvent. A creditor of the settlor who can prove the transfers to the trust rendered the settlor insolvent would have the right to set-aside the later transfer to the trust as a fraudulent conveyance, but that later transfer to the trust would not make the trust invalid from its inception, nor would it permit the creditor to access other assets transferred to the trust which had been transferred when the settlor was solvent. The latter would be a situation where the veil piercing equitable remedy would come into play making only those assets held in the trust that rendered the settlor insolvent available to satisfy the creditor’s claim, but no other assets then held in the trust.

Conclusion: It is hard to make much sense of the Blasingame decision, and its commentary with regard to what equitable remedies are available to a creditor to access assets held in a trust. I am not sure I agree with Judge’s Suttons’ view that a fraudulent transfer to an irrevocable trust always renders the trust void. To my knowledge, no Michigan court has yet to comment upon the availability of reverse alter ego and reverse veil piercing in connection with an irrevocable trust.